Universal versus contextual rationality: a case of Slovenia

2.2Specificity and importance of informal networks and grey economy

The extent of hidden economy in the 90’s in terms of unreported incomes in Slovenia might represent 17 – 21% of the recorded GDP. In its strategy for the development of small businesses Ministry of economic affairs had estimated, that “grey economy” represented 22% of official BDP in 1996. In 1995 around 26% of the active population or 239,000 persons actively participated in hidden or unreported activities (Kukar, 1995, pg. 16-25). In terms of working hours that would be enough to create some 80.000 new jobs. In the 1999 World Competitiveness Yearbook (IMD, 1999) Slovenia was ranked last out of 45 countries earning 2,19 points out of 10 for the highest extent of grey economy. It was also poorly ranked for the extent of tax evasion, transparency of financial institutions and public confidence in managers (Table 1).

Table 1: Indicators of the extent of hidden economy in selected countries in 1999

	Grey economy			Tax evasion			Transparency of financial institutions			Public confidence in managers
	A	B	C	A	B	C	A	B	C	A	B	C
Austria	4.87	3	1	5.47	15	3	7.08	18	7	6.85	14	5
Belgium	4.41	8	2	2.45	40	12	7.55	8	4	6.45	21	7
Spain	4.39	10	3	5.09	18	5	7.11	16	6	6.71	16	6
Finland	4.26	11	4	7.02	4	1	7.93	1	1	7.57	2	1
Hungary	4.20	13	5	3.06	30	8	6.35	25	9	5.53	37	9
Netherlands	4.17	14	6	5.67	14	2	7.76	4	2	7.02	9	3
Denmark	4.15	15	7	5.43	17	4	7.72	5	3	7.24	4	2
Portugal	3.76	23	8	2.92	32	10	7.12	15	5	6.37	24	8
Ireland	3.72	24	9	4.84	20	6	6.61	22	8	6.94	12	4
Czech Republic	2.75	41	10	2.54	35	11	4.11	42	12	3.36	47	12
Poland	2.64	42	11	3.23	28	7	4.70	40	10	5.19	41	10
Slovenia	2.19	45	12	2.94	31	9	4.31	41	11	4.50	44	11

Legend: A – Mark (1-10); B – Overall ranking; C – Ranking among the 12 selected countries

Source: The World Competitiveness Yearbook 1999, IMD

Grey economy in Slovenia was acting as a kind of a social buffer, soothing the transition and making social peace possible in spite the fact that in the year 1993, for example, some 130,000 people or 14,4 percent of active population were unemployed (SURS, 1993). It is believed that when situation would stabilize the share of informal economy in the GDP would fall, since growing number of “afternoon” operations would either decline or become legitimate businesses.
Informal networks and grey economy are to a certain extent present in all world economies. They are usually viewed as an obstacle to free competition that in the end reduces the potential GDP of the country. But in some cases, allocation through the informal networks and moonlighting economy can be beneficial for country’s development. We assert, that this contextual factor has significantly contributed to the success of Slovenian economy under socialist regime and has been beneficial also since the 19^th century. We believe that it has survived and even thrived during the last transition and that some of the mistakes of that period are the result of mostly not seriously taking into a consideration the impact of informal networks and grey economy. However, we think that grey economy has become one of the important obstacles for the future economic development in Slovenia. One of the major challenges for managers and politicians of this time is to find a way to mobilise hidden power, creative energy and entrepreneurship of informal economy and to incorporate it into a formal one which should become more internationally competitive.
In the 19^th century “moonlighting” was essential for the survival of Slovenian peasants and their communities. After the abolishment of feudalism in 1848, Slovenian farmers were stuck with small farms, which they had to buy from previous landowners. In order to do so, they had to take loans in newly created saving and mortgage banks. They were heavily taxed by the Austro-Hungarian Empire due to military needs for protection of borders. In addition, the hereditary rule stated that the heir had to pay a fair share of the inheritance to his brothers and sisters in money, or the farm was divided in equal parts. Because of that, and because of the rough farming conditions of the mountainous terrain, small farmers were prevented from accumulation of wealth and discouraged to embark on any entrepreneurial activity that would enable them to improve their farming conditions (Kristensen, Jaklic, 1998). Even today, after one and half century, Slovenian farms are extremely small compared to other European countries¹⁴. Since farmers were constantly living in a state of crisis, struggling to produce enough to be able to pay rent, taxes and inheritance claims, they gradually began to cooperate and help each other within their local communities. They started producing wooden crafts or textile and offering various services on local “grey” market. United in face of a “foreign occupier” they gradually institutionalised a system of reciprocity of services and help among neighbours. Rather than to participate in an economy built on principles of market exchange, they developed a system which could be kept secret and untaxed from the Empire authorities and which for these very same reasons had a high degree of legitimacy among the population. The problem was that this unofficial, “hidden” economical system could not by itself generate the money incomes necessary for it to be self-sufficient. Thus farmers were forced to generate supplementary wage-incomes from sources outside the system. Depending on what was available in their valleys they started to work in the forests owned by the catholic church or in a mines, sawmills and factories owned primarily by foreigners. Because income from the factories and mines was only a supplement to their farming income, it was in a way a subsidy to the mine and factory owners, who were paying very low wages to their workers. Thus the hidden valley system of mutuality and formal foreign capitalist system cohabited in a mutually reinforcing way. Since none of the systems permanently succeeded in dominating the other, they were able to coexist up to the end of the Second World War.
After the WWII, partisans knew that the easiest way to gain local support, create legitimacy in a rural society and simultaneously establish authority, was to simply allow people to live on their small lots and to create enterprises that would offer “workers” additional, though not necessarily very high wages (Kristensen, Jaklic, 1998). Thus factories that have been established at the end of WWII could simply be seen as collective associations for the provision of money in terms of wages. The workers could still conceive of themselves as farmers and orient their life and careers toward this form of life with the necessary additional income being provided for as a collective good organised and managed by the socialistic state. Those without land, eg. craftsmen and technicians, would also find their challenges in the surrounding community, where their skills were welcomed among the house building neighbours and friends and not in a formal economy where they kept working on undemanding and unchallenging jobs. The decisive sign of community integration was the “house and garden”, because this could only be achieved through active participation in the moonlighting, which meant learning how to play the secret game of local mutualism.
On the higher level, former partisans, now successful politicians and/or managers, played a similar game of allocation politics. Just like local communities, they have acted by the rules of mutualism and reciprocity on the national level. Although different fractions of partisans competed mutually to dominate the enterprise sector and to gain influence in different state agencies, they have also collaborated with each other and negotiated about the allocation of state funds. Thus, the success of a manager was dependant more on his “connections” and networks that he has belonged, that on economic performance of his enterprise. As long as he was producing satisfactory business results it was his ability of successful lobbying which was important for the development of local community and companies.

2.2.1Moonlighting and informal networks in action: Case of Ljubljana Stock Exchange

With the case of Ljubljana Stock Exchange we would like to show how strong “background institutions” are even with respect to a new institution and how the same old behavioural of informal relationships and patterns from the past decades or even centuries are repeating.

In the year 2000 the turnover of Ljubljana stock exchange reached 269,6 billion tolars and it’s nominal annual growth has slowed to 1,5 percent (Repovz, 2001). At the same time the amount of direct “bundle trading”, where stock exchange was just notified after the transaction, amounted for 156 billion tolars, which was more than 20% higher than previous year. Turnover on the unofficial “grey market” came to 171 billion of tolars, with annual growth of around 30%. In fact, unofficial and untransparent turnover added up to 327 billion tolars, or 22% percent more than stock exchange turnover. For some observers the figures are startling und worrying. The transition is almost over, but the “grey trading” is not declining, more, it keeps flourishing.
Various explanations and solutions were offered to make clear and to abolish this anomaly of Slovenian capital markets. Relying on the historical evidence we assert that these developments are just a continuation of an old tradition of moonlighting and relying on the contacts and informal networks, which have altered itself and adapted to a new environment. Some new institutions, like Stock Exchange, were simply copied from the anglo-saxon world, because it was a modern thing to have them. It was believed that just by introducing these institutions transition economies could transform their economies from planning to market economies. But contextual factors can not be ignored and the case of Ljubljana Stock Exchange clearly shows that these institutions if not introduced properly degenerates into some sort of “freak” institutions. Some Slovenian intellectuals with deep understanding of the nature and peculiarities of previous and present economical and political systems, have consciously or instinctively followed the holistic approach and had suggested the alternative for the key priority of transition - the abolishment of the social ownership of business enterprises.¹⁵ But political leaders have decided to listen primarily to foreign experts and consultants (the prominent place among them has Harvard economist Jeffery Sachs) who offered universal solutions, and to ignore experienced domestic economists, as they perceived to be “contaminated” by the previous system.
When Ljubljana Stock Exchange was founded in 1989 it was first such institution in Yugoslavia and was widely celebrated (or criticized) as a major step toward western, capitalistic economy. In November 1992 The Law on Ownership Transformation of Companies was passed by the Parliament. It has introduced a combination of free distribution and commercial privatisation of companies. The basic transformation scheme was that 10% of a company’s shares were transferred to the Compensation/Restitution Fund, 10% to the Pension Fund, 20% was designated for free distribution to all Slovenian citizens via ownership certificates, 60% were available for internal free distribution to employees via ownership certificates, or shares were sold on preferential terms (50%) discount to insiders under a special internal buy-out scheme, or on commercial terms through public offering of shares, public tender of public auction. It was expected that real privatisation in the economic sense would be achieved gradually. After the initial allocation of shares, a process of concentration of shares in hands of active owners would enable greater efficiency of economy. Stock exchange was expected to play a major role in that process. Throughout the 90’s the major function of secondary capital market was the “consolidation of social property” (Mramor 2000). If we disregard a few cases of financial institutions issuing securities, primary capital market was virtually non-existent. However, as we already suggested, even the role of redistributing wealth was performed relatively poorly.
To avoid severe plummeting of share prices caused by excess supply of shares from small shareholders that wanted to cash in their “gifts” from the state as soon as possible, and to limit the risk of negative effects on interest rates and economic growth, two year moratorium was put on a transfer of shares from internal distribution. Shares from internal buy-out were transferable only between participants of the internal buy-out until the programme concluded. That was the start of the “grey stock market”. Although it was legally unlawful to sell these shares, various “stock-brokers” had used an arsenal of legal tricks including futures contracts combined with high pressure selling to persuade small shareholders to sell them their shares with generous discount. After the initial redistribution of shares, trading on the grey market has slightly declined, and trading on the stock exchange has grown, mainly because of foreign institutional purchases. But in the beginning of 1997, Bank of Slovenia introduced obligatory custody accounts for all foreign portfolio investments in order to protect the macroeconomic stability of the economy. Stock players have succeeded in persuading the public, that these restrictions have in fact resulted in cessation of foreign purchases and decline in scope of trading on stock exchange. But some economists believed that that was not the main reason for stagnation of the stock market. They have emphasised the role and power of managers, which did not have any interest to participate in stock exchange.
Off market trading started to thrive once again, this time with the shares of Mutual Investments Funds. Actually, most people didn’t invest their certificates directly in the companies, but have rather exchanged them for the shares of so called Authorised Investment Funds (AIF), which were in turn supposed to acquire stakes in various public companies, diversifying portfolio and thus reducing the risks (same as mutual investments funds in developed economies). Through lavish and costly marketing campaign in a country that has only two million inhabitants, AIFs succeeded in attracting around 1,2 million of shareholders (Giacomelli, 1999). But when the time came to invest them into the shares of real companies there was not enough companies left to invest in. The government has overestimated the value of “social” property that was liable for privatisation.¹⁶ AIF’s were left with unused certificates and were not able to operate properly nor to officially become listed on stock exchange. Shareholders, which were on average quite uninterested in whole “stock business”, tempted by the offers from various stock brokerages or independent “entrepreneurs” started to sell their shares for the fraction of nominal price. Managers of AIF have also contributed to the growth of grey stock market. In a highly informal manner they started to swap packets of shares of companies in order to shape a more compact portfolio and take active role in corporate governance or just to present their balance sheets in a more favourable way.¹⁷ These transactions did not go through official stock exchange market but were just reported after their execution. Due to these transactions nominal value of assets of AIFs was artificially raised, which allowed for the companies that manage AIFs (usually owned by banks) to realise profits of 5,1 billion tolars, although the funds that they have managed experienced loss of 40 billion tolars in 1996 (Giacomelli, 1999).
Many managers of companies have used “grey market” trading for the concentration of ownership but also for hostile takeovers of other companies. Through various informal meetings, managers of acquiring companies tried to persuade their more or less close friends who held leading positions as managers of other companies or financial institutions to sell them their shares in company they wanted to acquire. In the same manners managers of the “victim” company, which was as a rule always against the acquisitions, tried to convince the same “friends” not to sell their shares.¹⁸ Whatever the deal was, following transactions were rarely carried out through the stock exchange.¹⁹
Heritage of the past and customs acquired through the decades of operation are hard to change in a single decade of transition. The fact is that informal economy and networks have a long history of relatively successful activity. Although in the long run their efficiency could not be compared to that of a market economy, they contributed to a higher standard of living in the past and probably to a less painful transition in the 90’s. Old socialistic economy was formally abolished and new market economy with all its appendages was introduced, but the old ways of doing things have survived. That is one of the major reasons for the stagnation of Slovenian stock market. All major economic players including managers, financial institutions and government officials prefer to do their business on informal basis through direct negotiations and avoid stock market and its institutions. Since they all participate in the grey market, except for the lonely voice of the Ljubljana Stock Exchange, there is no real interest in abolishing it for the being.

2.2.2Could it be done differently

At the end of the 80s and at the beginning of the 90s some economists have suggested different approach, closer to holistic approach to rationality, to the subjects of privatisation and establishment of capital markets in Slovenia. Ribnikar (1994) argued that privatisation that was proposed by foreign experts and some domestic politicians is inappropriate and would only aggravate the transition, because it did not consider properly the essence of the previous system. Ribnikar (1998) has suggested different kind of privatisation that took into a consideration the real condition of the economy and some contextual factors like high power of managers. According to him, “social capital” should belong to all the people, but shares should not be distributed to them. It should be transferred to an institutional investor in form of preferential shares.²⁰ This public institutional investor would be passive but firm owner of the company, meaning that it would not be in a hurry to sell its share and would demand adequate return on equity. Only in case of the most important business decisions like selling or acquisition of the company or in case of unsatisfactory performance of managers would it exercise its right as an owner. The right to actively manage the company would belong to a private investor or investors which would bring new capital to the company.²¹ The nominal amount of “public” equity in company under management of public fund would stay the same, but its share in a company would gradually reduce. This kind of privatisation would be socially acceptable and probably economically more efficient than the selected one. All people would benefit from it in the long run and on more equal footing. Managers (new investors) would be interested in increasing the value of the company. Money of companies would be saved.²² General savings and investments would not decrease and personal consumption would not increase as it was the case with the selected privatisation scheme.